Game theory with pipelines

It seems every winter brings a new situation where Russia is holding up one of its neighbors, or one of them another one, over the delivery of natural gas. The pipeline transfer of natural gas through various countries seems to be the perfect example of a problem that has been haunting human history since trade began: local fiefdoms extracting tolls on transiting merchandise. The case of natural gas is a very pure example, because it is rather difficult to find an alternate route, given the gigantic fix cost of laying the pipeline.

Yet, there is talk of constructing some new pipelines to circumvent the hold-up problem. The question is what the new route should be. Technical considerations are here secondary, capacity and supply as well, all that matters is how bargaining power is impacted. Franz Hubert and Onur Cobanli use cooperative game theory and Shapley values of coalitions to analyze three proposed pipelines. The best seems to be North Stream, which runs thorugh the Baltic Sea from Russia to Germany, bypassing all the troublemakers. South Stream, which goes through Bulgaria and then the Balkans or Greece and Italy, is of little strategic value, as too many players are involved. And Nabucco, which taps fields in the Middle East and runs through Turkey and Bulgaria is of substantial value, but the rents accrues mostly to Turkey.

Why LIFO beats FIFO

When I write a blog post, it is usually about the last paper I read. I draw from a pile that goes by the LIFO principle, "last in, first out." That guarantees that my "stories" are super-fresh, but when there is nothing I go down the pile. I could use the FIFO principle, "first in, first out," which would give each paper a fair chance to be featured, but then I may end up with papers that are always older, instead of just occasionally (there are several dozen papers on the pile). Well, it turns out my principle is in fact better than FIFO (well not exactly, my case is different, but anyway).

Trine Tornøe Platz and Lars Peter Østerdal model a situation where people queue for service (say, boarding an airplane), where there is a bottleneck but it is open at all times. Agents then decide to queue depending on the way they are served. Suppose the cost of waiting is linear in time, people like to be served early, and everyone can be served. Then it is better to implement LIFO than FIFO. Indeed under FIFO, there is no reason for people to wait, they all come at the earliest possible time and have to wait the longest possible period. Under LIFO, there is less of an incentive to come early, indeed the first ones are not served first if anybody arrives right after. Waiting time is then reduced and everybody is better off, in expected terms.

Risk taking and the menstrual cycle

Women are grumpy during their period, and they have good reasons to be so. That this can impact some of their decisions should come as no surprise, yet it can be useful to determine how and how much.

Matthew Pearson and Burkhard Schipper do this by running an experiment that tries to tease out risky behavior and find that women bid higher in an auction when in the most fecund phase of their menstrual cycle or when they are on hormonal contraceptives. OK.

But wait, much like in an infomercial on TV, there is a bonus. In a second paper, the same authors find that the ratio of the length of the index and ring fingers of the right hand has no impact on risk taking. While that seems to be a rather odd measure to look at, there is a good reason to do so. But what annoys me that this is the exact same experiment as in the previous paper, they just use a different characteristic of the participants.

This is a bad case of turning a research project into many thin salami slices. The authors did not even bother rewriting much of the paper, with many part being cut-and-pasted from one to the other. Sadly, this second paper is already scheduled to appear in Experimental Economics. What are we to expect next? A paper about hair color? Astrological sign?

Contracts with empty promises

I always feel small talk has no specific purpose and is a waste of time. In fact, every time somebody asks me how I do, I launch into a well reasoned explanation of my current state of affairs, while my intelocutor is just expecting a "well-thanks-and you?" Yet, some people have found value in such chitchat, see a previous report. But what about contracts that have clause that have no chance of being met? Why would one allow empty promises in a legally binding contract?

David Miller and Kareen Rozen look at contracts that involve team work in a complex production environment, where opportunities for moral hazard abound. Performance clauses are hard to specify and you want to use peer monitoring and pressure rather than checking for the result of each individual task. Obviously, monitoring is costly, and along with statistical complementarities in the success rate, this implies that it could be optimal to delegate all the production to one person and the monitoring to another (the least productive one, according to the "Dilbert Principle"), and the latter may resort to wasteful punishment: naming and shaming, and even firing. It is wasteful, because it does not provide any direct benefit to the supervisor and it may not even be subgame perfect. Where are the empty promises? The one performing tasks can promise to fulfill them, but it obvious to all that they cannot be all successful because of some outside probability of failure. But the supervisor is willing to forgive failures, without knowing whether chance or moral hazard are at play.

Why is blackmail costly?

Blackmail is a strange concept. Threatening to reveal information is legal. Asking money for a service is legal. But doing both at the same time is illegal. Even stranger, when the transaction is initiated by the one who could be harmed by the revelation, this is technically a bribery, it is legal. So why this difference? The conventional answer is that blackmail is about rent-seeking. But if the damaging information is freely available, there is no welfare loss justifying the criminalization of blackmail.

Oleg Yerokhin claims the justification can lie within the bargaining power structure between the two parties. Indeed, when the information holder is a monopolist, he will have more power than socially optimal, and should thus be punished to internalize this cost. But when the target is a monopolist, then the outcome reverses, and the blackmailer should be subsidized rather than punished. Yet, I hardly find this argument convincing on the grounds that blackmailers are certainly less likely to be monopolists than victims. Indeed, information is duplication at zero or close to zero cost, making it difficult for a monopoly to arise in such a situation. But this information can easily be about one particular person only.

Emotions in economic interactions

How do you get people to cooperate. By increasing utility, of course, but that is difficult to measure, obviously, and there may some components beyond rationality in emotional contexts. However, we have some interesting ways to get some neurological hints about positive and negative emotions by measuring the conductance of skin. This may help to explain why people are sometimes willing to hurt themselves in order to punish others.

Mateus Joffily, David Masclet, Charles Noussair and Marie-Claire Villeval conduct an experiment where cooperation, free-riding and punishment can happen. They measure skin conductance to reveal the intensity of emotions and let players reveal whether their emotions are positive or negative. Cooperation and punishment of free-riding elicit positive emotions, the latter indicating that emotions can override self-interest. That is also because punishment relieves some of the negative emotions from observing free-riding. And one does not like being punished, which lends one to cooperate more in the future. Finally, people like being in a set-up where sanctions are possible, in particular because it allows a virtuous circle of emotions that reinforce each other and lead to more cooperation.

Market failure and political outcomes

In a perfect economic world, perfect competition and the lack of frictions or externalities make it possible to obtain the most efficient outcome. But once any of those assumptions is lost, outcomes are going to be worse than the first best. In particular, once there are rents to be obtained, from frictions or imperfect competition, the beneficiaries of those rents will try to protect them. And they will try to influence political outcomes in their favor.



Madhav Aney, Maitreesh Ghatak and Massimo Morelli argues that this influence peddling reinforces the market failures. As an example, they take a model of misallocation of entrepreneurial talent due to the imperfect observability of that talent. The resulting power structure then votes on institutions that reinforce such a class structure and thus amplify misallocations and market failures.



Now think about the apparently ever-increasing proportion of lawyers in the political class.

Procrastination in team work

Teamwork can turn out very bad when moral hazard is present: if people do not trust each other or care about each other, nothing gets done. When doing research, we are lucky to be able to choose our co-authors, but even then things can turn for the worse if a team member looses interest. And we remember how bad it is when a team is forced upon you during our studies. Now, this is all very loose reasoning, let us get on firmer ground.



Philipp Weinscheink studies team production in a dynamic game with moral hazard. If all players are rewarded equally, they will all wait until the last moment to participate. This is very like what we often see in political negotiations with a deadline, where nothing happens until the last moment, and player consciously wait for the last moment. The same often happens at collective agreement bargaining. And of course, the outcomes are far from optimal, as the debt ceiling mess in the US has recently shown.



If the rewards are not equally distributed, the outlook is better. Quite obviously, those who are rewarded better will tend to procrastinate less. But they are not necessarily better off that those less rewarded, as they put more effort. Thus, second-best contracts are unequal ones. But all this falls apart if some players have limited liability (which means they have better outside options) or if some can sabotage. Then everyone will wait until the last moment and very little gets done. Think about the US situation again...

How should I lie?

Is it OK to lie? The usual answer is that it depends. Big lies are frowned upon, while small lies are somewhat tolerated. Does this necessarily mean I should avoid lying?

Gerald Eisenkopf, Ruslan Gurtoviy and Verena Utikal study the size of lies in an experimental setup. Their first observation is that it depends whom you are lying to. Honest people punish according to lie size, while chronic liars really do not care. Their second is that big lies are punished more than small lies. This is hardly surprising. What would have been more interesting to learn would be whether the punishment function is concave or convex, that is, whether the returns to scale are increasing or decreasing. In some sense we already have some idea about this by looking at tax penalties, which are usually proportional to the offense, plus a fix cost. And ultimately, one would want to compare the shape of the penalty function to that of the benefit function. Then I would finally know whether I should lie big or small.

The daycare assignment problem

Assigning people with heterogeneous preference to medical residency, schools, job candidates or marital partners is a difficult problem, and with the help of the work of Al Roth, we have made much progress in finding optimal systems. More and more situations are uncovered that required a special analysis because some feature requires rethinking the whole process.

John Kennes, Daniel Monte and Norovsambuu Tumennasan study assignments of toddlers in daycares as applied in Denmark. It is special because if the overlapping generation nature of daycares, and the fact that some children get preferential treatment (like previous attendees and siblings). The usual Gale-Shapley algorithm appears to be Pareto-optimal, at least among stable matching algorithms, as in simpler setups, but it is unfortunately not strategy proof and does not Pareto dominate all strongly stable algorithms. For once, another assignment mechanism seems to perform better. But I wonder what would happen when there is rationing in daycares, as is typically the case.

Shortsightedness and tariffs

International trade theory is in large part about optimal trade theory, yet it is incapable to explain the observed level of tariffs. While under rather general circumstances theory will tell you that zero tariffs will improve general welfare, once you take into account that governments threaten and negotiate in a Nash equilibrium, tariffs should be at about 30%. They are generally far below that. It is a big challenge to explain the difference.

Mario Larch and Wolfgang Lechthaler argue that all that is needed is for trade theory to finally catch up with the rest of economics and use some dynamics. Specifically, transform the problem into a dynamic Nash equilibrium, take into account transition paths, and you get some realistic numbers if you assume that the negotiating politicians are short-sighted, which is certainly not far from the truth. This is important because the various transitional effect of a tariff change take different times. Indeed a decrease in tariffs has a faster and positive impact on consumption through an immediate increase in consumption. A counter-effect through the closing of inefficient firms takes much longer. Impatient politicians discount heavily the latter.

Using public firms to regulate the environment

There are various approaches to regulate the pollutions of firms. One can regulate them, one can tax them, or one can create a market for pollution permits. Or one can ask the firms to self-regulate them. Or the government can take over one firm and let it set an example. Which option works best depends on market conditions and how emissions can be observed.

Davide Dragone, Luca Lambertini and Arsen Palestini look at a Cournot oligopoly for the last option. We know that when competition is less than perfect, less will be produced, which is good when the externality is negative. To adjust production to the right level, the public firm choose output and price to coerce the private firms to do the right thing. Basically, the latter are forced to internalize the externality. But this only works if there are not too many firms. The public firm reduces output such that the private one reduce as well, due to lower aggregate output and increased market power. One could thus imagine the government simply shutting down firms. But of course, this is valid only if there is no free entry in the industry, a big if.

On banning Youtube at work

While a strong case can be made that the information technology revolution has markedly improved productivity at the workplace, it is not that obvious that Internet at the workplace has such a positive impact. Indeed, it is very tempting to get distracted, and Youtube has certainly contributed to a shorter attention span in offices around the world (not to mention that these flash applications are huge resource hogs that require better and better computer equipment). And I cannot deny the Internet is providing me with a distraction that prevents from pursuing my regular duties, this blog for which my employer is not getting any credit whatsoever. Is then the solution to ban the Internet from work?

Alessandro Bucciol, Daniel Houser and Marco Piovesan do an experiment where some people get to see a funny video while others do not. The "frustrated" ones then turn out to be less productive thereafter. One should thus weigh whether to forbid the Internet, yes it wastes time, but you do not want to create this frustration effect. The authors conclude some basis that eludes me that the second effect is stronger.

But wait a moment. The experiment they perform is based on the fact that the frustrated ones hear a video but cannot see it. How would this relate to the Internet being banned from work? If that were the case, no one would hear the video and no one would get frustrated. And no time would be wasted. I cannot follow the authors' reasoning here. Maybe I am too distracted by the Internet.

Why American politicians lie

Many advertisements are misleading, with the intend of making people buy goods they would not buy had they known the truth. This overconsumption leads to welfare losses, which is why you would want to regulate truth in advertising. But, in a market that is not competitive, households tend to consume less than optimal. Does this mean we should then avoid regulating ads, or regulate them less, in order to get to the optimal quantity of consumption?

This is the question Keisuke Hattori and Keisaku Higashida ask with a model of false advertising in a duopoly. They suppose that consumers are easily fooled and ads of one firm also increase demand for the other firm's good. They show that prohibiting truth in advertising (or educating consumers) may have negative welfare consequences if the goods are close to homogeneous because of the resulting under-provision of goods. But taxing misleading or joint advertising is welfare improving. In an interesting extension where there are smart and naive consumers, smart consumers suffer because the naive ones induce more misleading ads and higher prices.

Now think about politicians. There are only two parties who offer goods that are after all little different from each other. Voters are easily fooled. The model above implies that politicians will lie extensively and deliver very few goods. Draw your conclusions.

Using the WTO to overcome a prisoner's dilemma

It looks like the threat of competitive increases in trade tariffs has vanished, at least for the moment, as economies are getting back in shape. This episode highlighted how tariffs are part of a prisoner's dilemma: increasing tariffs is good for you, at least in the short term, as it gives more market share to local firms and/or more revenue to the state. But it hurts the foreign country, and if everybody does it, joint welfare is reduced because of the lower gains from exchange, the misallocation of productive resources and the loss of competitiveness of protected industries. It is precisely because of this prisoner's dilemma that the GATT (General Agreement on Tariffs and Trade) and then the WTO (World Trade Organization) were put in place.

Renee Bowen takes this reasoning further by looking a at a multilateral prisoner's dilemma, and interestingly the optimal institution that emerges looks very much like WTO's dispute settlement mechanism, in that countries cannot retaliate while a dispute is being settled. The key is that once a large enough number of countries participate in the WTO, the threat of sanctions is sufficient to obtain settlement and nobody is compelled to jump the gun with retaliations.

The smart children of vengeance

As someone who has been raised in a non-violent environment, I am often surprised how people in some circles easily resort to vengeance and violence while a conciliatory attitude could have resolved "issues" quickly and efficiently. There is certainly a good deal of learned behavior that determines whether you are of a conflicting or conciliatory type, and this learning comes from example, in the family, among peers and in society. Society is important (say, compare Scandinavia to the Balkans) but there are also striking differences within societies. That is where parents may come in.

Ruby Henry studies how the use of retaliation is transmitted to children, first using a model of education effort by parents, and then using UK National Childhood Development Survey. The theoretical prediction is confirmed that high-cognitive parents are better able to transmit their values and override the peer culture, as long as the parents are retaliators. Indeed, if a child is told to retaliate and meet a forgiver, he wins and his values are reinforced. If he is a forgiver and meets a retaliator, he looses and is upset by the teachings of his parents. It the long run, this means that humankind will settle on a retaliating culture. But I do not think this is what we observe. In fact, there are less wars, people abide more to contracts and, I think, respect more the rule of law over time. Correct me if I am wrong.

A neolithic prisonner's dilemma

Why did humans adopt agriculture in Neolithic times? Our intuition would say because it has better nutritional outcomes. But the evidence points to the contrary: the bones of early farmers consistently show poorer health than the preceding hunter-gatherers. So why would agriculture be adopted if it lead to a disadvantage?

Robert Rowthorn and Paul Seabright say it was individually rational to adopt agriculture, even though it was detrimental to society, much like in a prisoner's dilemma. The problem of a farmer is that he needs to defend his land and his cattle. That seems an additional disadvantage with respect to hunter-gatherers. But farmers can team up in villages, and fortify them. And voilà, now that they have a secure base, they can start raiding around them instead of only defending. This is where the prisoner's dilemma comes in: it is individually rational for every farmer to dedicate resources to defense, but this lowers everyone's welfare.

And thus started the grip of the defense industry on the economy.

Revenue sharing in rock bands

Rock bands are often volatile associations. While there may often be conflicts about the creative orientation of the band, conflicts are too often about jealousies regarding free riders or members who attract too much attention. Fundamentally, these are issues about contracting who does what and who gets what. In particular, when a band member is doing more creative work, should he also be getting a larger share of income (to reward creativity) or the same as the others (to avoid some jealousies)?

This is the question that Cédric Ceulemans, Victor Ginsburgh and Patrick Legros ask. The trade-off is clear: you want to attract more creative band members for its success, and you want to give them credit for this by giving them a larger share of the pie. So you may want to associate one creative musician with less creative ones (in a complete contract) or only creative ones (in a incomplete, uniformly sharing contract) depending on what it means for the probability of achieving a hit, and the type of contract will determine who wants to form a band and whether the band will outsource song writing (and how much effort each member puts into it). The theoretical analysis shows that under a complete contract, the more disperse the credits are, the more successful the band is (reflecting very much the winner-takes-all features of show business?). The relationship is negative for incomplete contracts, which is apparently true in the data. This means that bands are driven to write incomplete contracts.

Are wars rational?

There are few circumstances where wars are globally welfare enhancing. One can imagine that wars can be individually optimizing, for example when we consider the old land-taking or enslaving war. But casual empiricism indicates that quite often fools engage in wars, like minnows tickling obviously overpowering giants (Irak, North Korea) or others who have little objective chance of winning (South Ossetia, Caprivi, Falklands). Is it because some belligerent are poorly informed or even irrational?

Clara Ponsati and Santiago Sanchez-Pages use Markov games with fully rational players to characterize wars, and even chronic wars. A country can lay a claim on another country, leading to bargaining or war, and it can only end if one surrenders. The problem is that parties do not know their relative strengths and can only learn about them by engaging in war. Add a dose of optimism, and you have a recipe for war. Were one to add some political economy (or populism) to this model, outcomes would be really depressing and worrisome. But I still have some faith in humanity.

Is there really no selection bias in laboratory experiments?

Whenever you read about a survey or an experiment, the first worry one should have is whether there is some selection bias in the studied example. As I have argued before, experimental economics is almost exclusively on a sample from a minority of the world population. But assuming that we are only interested in this minority (and unfortunately we are), is there still some selection bias.

Blair Cleave, Nikos Nikiforakis and Robert Slonim did some experiments in the classroom with over 1000 students, and then invited them for more experiments in a laboratory setting. Those that followed the experiment did not have different characteristics, which is reassuring. However, this only partially alleviates my worries. Indeed, students are only a small minority of the current population, one that is more educated, coming from a richer background, younger, etc. I am looking forward to a broader study...